Economic Reviews

A. Definition
B. Input Information
C. Output Information
D. Additional Definitions

A. Definition

Investment Appraisal (or Capital Budgeting) is the decision-making process for investing in long-term assets, major capital investments or expenditures that is to determine and evaluate potential significant in amount of expenses or investments. The Investment Appraisal is usually involving the calculation of each project or asset future profit by period, present value (PV) of the cash flows, pay back the initial cash investment, assessment of risk, and other factors. The formal method of Investment Appraisal techniques: Net Present Value (NPV); Internal Rate of Return (IRR); Profitability Index (PI); Payback Period, etc.

Capital Investment Decision (CID) is a long term corporate finance decision based on key criteria to manage the company’s assets and capital structure. A CID includes allotting the capital investment funds of the firm in the most effective manner to make sure the best possible returns. Assessing projects as well as the allocation of the capital depends on the project requirements are some of the most crucial capital investment decisions aspects. (Refer to the FID (Final Investment Decision))

Final Investment Decision (FID) is the final decision of the Capital Investment Decision (CID) as a part of the long-term corporate finance decisions based on key criteria to manage company’s assets and capital structures. In general, FID can be made after completion of permits and financial arrangements, and ready for commencement of the construction works at the site (EPC Contract). They are the points at which contracts for all major equipment can be placed, allowing procurement and construction to proceed and engineering to be completed.

Economic Model is a simplified description of economic reality showing the interrelationships between selected economic variables. There are two broad classes of economic models: theoretical model - to derive verifiable implications about economic behaviour under the assumption, and empirical model - to verify the qualitative predictions of theoretical models and convert these predictions to precise, numerical outcomes. The standard model of supply and demand taught in introductory economics is a good example of a useful economic model.

B. Input Information

CAPEX (Capital Expenditure or CapEx) is an amount of money invested to acquire the new business or upgrade fixed assets that is invested in to maintain existing levels of operation within a company or in something new to foster future growth. A CAPEX is used repeatedly in production processes at full cost price that can be tangible (such as buildings, machinery, equipment, and facility), or can be intangible (such as patent). (Refer to the OPEX (Operational Expenditure))

Capital Cost is the cost associated with building the facility including the direct cost of purchase equipment, tools, and as well as the indirect cost. The Capital Cost does not include owner's production costs such as feed stock, operating utilities, and operations staff.

Corporate Cost consists of the cost of employees, marketing expenses, other corporate indirect costs, etc.

Depreciation is the gradual decrease in the economic value of the tangible asset that is assigned or allocated the asset value over the accounting period. A Depreciation schedule is required in financial modelling to forecast the value of a company’s fixed assets, depreciation expense, and capital expenditures. Depreciation Models are a straight line depreciation and exponential depreciation (or accelerated depreciation) model. Depreciation Terms: years, model, salvage value.

Depreciation Model is the formula that use to calculate depreciation of assets. The Depreciation Models are: 1) Straight Line Depreciation model is to assume that the asset decreases by a fixed amount every year until the asset reaches its salvage value. 2) Exponential depreciation (or Accelerated Depreciation) model is based on a fixed annual percent decrease that allows company to write off assets faster in earlier years than the straight line depreciation method.

Escalation is to ​become or make something increase in price, especially due to inflation or ​become ​greater or more ​serious.

Inflation is a sustained increase in the aggregate or general price level in an economy that is an increase in the cost of living. The Inflation (or deflation) in the project cost is usually expressed as the annualised percentage rate of change in the construction cost indices.

Insurance is an agreement in which an organisation or a personal (Insured) pays an insurance company (Insurer) money (insurance premium) and the insurer pays the insured costs as financial compensation of loss, damage, or injury by an accident or incident risks. The Insurance can be one of the risk transfer methods.

Maintenance Cost is the cost associated with keeping facilities in good conditions by regularly checking it and repairing it when necessary.

Operation is a practical work to produce products or the way of a part or an entire of machine, system, or plant work together smoothly and safely to produce products in accordance with the procedures.

OPEX (Operational Expenditure) or OpEx is the normal ongoing expenses for running a production, business, or system by which an organisation spends daily basis to keep going operations including the cost of workers and facility expenses, such as inventory costs, marketing, payroll, equipment, rent, R&D, advertising, and insurance. (Refer to the CAPEX (Capital Expenditure))

Owner’s Cost is the cost that includes a land, financial cost (funding cost), owner’s third party cost including engineering studies, permits, licensing fees, training, and owner corporate costs etc.

Salvage Value is the estimated resale value of an asset at the end of its economical or useful life.

Tax is a compulsory monetary contribution to the government that is based on an income, business profit, occupation, privilege, property, added to the cost of goods or services, etc. The Project related taxes are the various taxes that may be applicable to a specific project or initiative. (e.g., Income Tax; Sales Tax and Value Added Tax (VAT); Property Tax; Excise Tax; Customs Duties and Import Taxes; Employment Taxes; Environmental Taxes; Specialised Industry Taxes; Capital Gains Tax; Incentives and Credits; Local Taxes, etc.)

Total Investment Cost (TIC) consists of the capital cost (EPC cost), working capital, and owner’s costs includes land, financial cost, and operational costs, etc.

C. Output Information

Cash Flow is the actual and forecasted expenditure of cash during a specified period of time. The Cash Flow is the difference in amount of cash available at the beginning of a period (opening balance: forecast) and the amount at the end of that period (closing balance: actual) of a project or business.

Discount Factor (Df) is the percentage rate required to calculate the present value (PV) of a future cash flow. The Discount Factor Formula: Df = 1/(1+r)^n where, r = interest or discount rate or rate of return, n = time periods.

Discount Rate is 1) the reduced price that is offered to customers if they buy large quantities of products or services; 2) the rate of interest that a country's central bank charges for lending money to other banks; 3) the interest rate used to discount a stream of future cash flows to its present value. The Discount Rate often used in capital budgeting that makes the net present value (NPV) of all cash flows from a particular project equal to zero. Generally, the higher the internal rate of return (IRR) is more desirable for the capital budgeting review.

Discounted Cash Flow (DCF) is a present value of a future cash flow. A DCF is calculated by dividing projected annual earnings over an extended period by an appropriate discount rate, which is the weighted cost of raising capital by issuing debt or equity.  

Discounted Cash Flow (DCF) Analysis is a method of the future business or project valuation using the concepts of the time value of money. A DCF analysis is to determine the present value of future cash flows (future free cash flow projection and discount it). All future cash flow is estimated and discounted by using cost of capital to give its present value. If DCF analysis value comes higher than the current cost of the investment, the opportunity is a positive.

Discounted Cash Flow (DCF) Analysis Methods are the Net Present Value (NPV) method and the Internal Rate of Return (IRR) method, both of which take into account the time-value of money.

EBIT (Earnings Before Interest and Taxes) is an indicator of a company's profitability, operating earnings, profit, or operating income, of which EBIT is calculated as all profits before taking interest payments and income taxes. EBIT focuses on an organisation's ability to generate earnings from operations, ignoring variables such as the tax burden and capital structure that is a way to determine the profitability of a business by excluding interest and income tax expenses.

Internal Rate of Return (IRR) is the average annual return rate used in the capital budgeting to measure and compare the profitability of investments that is the one of the two discounted cash flow (DCF) techniques (the other is net present value or NPV).

Margin is 1) the ​profit made on a ​product or ​service that is a difference between a total sales amount from total cost including expenses; 2) the ​amount by which one thing is different from another or difference from the standard requirement; 3) the percentage added to a market rate of interest, or subtracted from a market rate of deposit, to provide a return to the bank. (Refer to the Marginal Cost)

Net Present Value (NPV) is the difference between the present value of all cash inflows from an investment or a project and the present value of all cash outflows required to obtain the investment or to finance the project at a given discount rate. The formula for NPV = (Cash inflows from investment) – (Cash outflows or costs of investment)

Payback Period is an investment appraisal technique that evaluates the period of time required for the return on the investment.

Present Value (PV) is the current value or present discounted value that is the value of an expected future income stream determined as of the date of valuation.

Profitability Index (PI) is the investment appraisal technique that measures a ratio between the present value of future cash flows and the present value of costs for the project.

Rate of Return is the income earned by holding an asset or investment over a specified period.

Return On Investment (ROI) is a profitability measure that is the evaluation of the business performance by dividing the benefit (or return) of an investment by the cost of the investment, and the result is expressed as a percentage or a ratio. A high ROI means the investment gains compare favourably to investment cost.

D. Additional Definitions

Break Even (or Breakeven Point) is to have no gain (profit or benefit) or loss at the end of a business activity. The Break Even is reached when the total revenue or income exactly matches the total costs, and the business is not making a profit or a loss, also a financial result reflecting neither profit nor loss.

Capital Asset Pricing Model (CAPM) is a model used to determine a theoretically appropriate required rate of return of an asset that describes the relationship between the expected return and risk of investing in a security. A CAPM model shows that the expected return on a security is equal to the risk-free return plus a risk premium, which is based on the beta of that security. E(Ri) = Rf + βi * (E(Rm) - Rf), where: E(Ri) is the expected return on the capital asset (i), Rf is the risk-free rate of interest (e.g., government bonds), βi is the sensitivity of the expected excess asset returns to the expected excess market returns (i), E(Rm) is the expected return of the market.

Compound Annual Growth Rate (CAGR) is the rate of return (RoR) for the geometric progression ratio from its beginning balance to its ending balance that provides a constant rate of return over the time period, assuming growth takes place at an exponentially compounded rate. A CARG is used to a business investment analysis (e.g., revenue, units delivered, registered users, etc.), and CAGR = (EV/BV)^1/n - 1 where, EV = the ending value, BV = the beginning value, n = the number of years

Deflation is a general and continuous decrease in the prices or amount of money in circulation as a sustained fall in the general price level.

Discounting is the process of determining the present value of financial and economic analysis that determines the present and future values of investments or expenses.

Disinflation is a drop in the rate of inflation, or a decrease in the rate of inflation that is used to describe the slowing of price inflation. Disinflation is commonly used by the Federal Reserve (Fed) to describe a period of slowing inflation which refers to the direction of prices, and the rate of change in the rate of inflation. The MIT Dictionary of Modern Economics defines deflation as "A sustained fall in the general price level." Deflation represents the opposite of inflation, which is defined as an increase in the overall price level over a period of time. In contrast, disinflation, represents a period when the inflation rate is positive, but declining over time.

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortisation.

Exchange Rate (FX Rate)

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